In
investing
Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort.
In finance, the purpose of investing i ...
, upside risk is the uncertain possibility of gain. It is measured by
upside beta In Investment#In finance, investing, upside beta is the element of traditional Beta (finance), beta that investors do not typically associate with the true meaning of Financial risk, risk. It is defined to be the scaled amount by which an asset tend ...
. An alternative measure of upside risk is the upper semi-deviation. Upside risk is calculated using data only from days when the benchmark (for example S&P 500 Index) has gone up.
Upside risk focuses on uncertain positive returns rather than negative returns. For this reason, upside risk, while a measure of unpredictability of the extent of gains, is not a “
risk
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environme ...
” in the sense of a possibility of adverse outcomes.
Upside risk vs. Capital Asset Pricing Model
Looking at upside risk and
downside risk
Downside risk is the financial risk associated with losses. That is, it is the risk of the actual return being below the expected return, or the uncertainty about the magnitude of that difference.
Risk measures typically quantify the downside ris ...
separately provides much more useful information to investors than does only looking at the single
Capital Asset Pricing Model
In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.
The model takes into accou ...
(CAPM) beta. The comparison of upside to downside risk is necessary because “
modern portfolio theory
Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversificatio ...
measures
risk
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environme ...
in terms of
standard deviation
In statistics, the standard deviation is a measure of the amount of variation or dispersion of a set of values. A low standard deviation indicates that the values tend to be close to the mean (also called the expected value) of the set, while ...
of asset returns, which treats both positive and negative deviations from
expected return
The expected return (or expected gain) on a financial investment is the expected value of its return (of the profit on the investment). It is a measure of the center of the distribution of the random variable that is the return. It is calculated ...
s as risk.”
In other words, regular beta measures both upside and downside risk. This is a major distinction that the CAPM fails to take into account, because the model assumes that
upside beta In Investment#In finance, investing, upside beta is the element of traditional Beta (finance), beta that investors do not typically associate with the true meaning of Financial risk, risk. It is defined to be the scaled amount by which an asset tend ...
and
downside beta In investing, downside beta is the beta that measures a stock's association with the overall stock market (risk) only on days when the market’s return is negative. Downside beta was first proposed by Roy 1952 and then popularized in an investment ...
are the same. In reality, they are seldom the same, and making the distinction between upside and downside risk is necessary and important.
See also
*
Cost of capital
In economics and accounting, the cost of capital is the cost of a company's funds (both debt and equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate new ...
*
Dual-beta
*
Macro risk Macro risk is financial risk that is associated with macroeconomics, macroeconomic or political factors. There are at least three different ways this phrase is applied. It can refer to economic or financial risk found in capital stock, stocks and f ...
References
External links
Risk Arbitrage: An Investor's GuideFinancial Enterprise Risk Management
{{DEFAULTSORT:Upside risk
Financial risk modeling